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Finance Definitions: Annual Percentage Yield

Last week we took a look at compound interest and how that affects how quickly your money grows. But comparing potential banks, savings accounts, and CDs based on compound interest rates can be much easier by checking out the Annual Percentage Yield (APY).

What is Annual Percentage Yield?

Looking at compound interest taught us that banks will pay you interest on top of the interest that you earn. The more often the account is compounded, the more often the interest is calculated and added to your account -- i.e. you get more money. So, we now know how to figure out what we'll earn, but who has the time (and Excel spreadsheets) needed to determine the best combined compound rate and interest rate in town?

This is where Annual Percentage Yield can help. APY (also known simply as "Yield") calculates a bank’s basic interest rate and the compounding rate to provide you with a comparison tool. All banks must use the same calculation for their APY, so comparing APYs will allow you to shop for the best rate in town. Now you're comparing apples to apples and you don't have to worry about how often the account is compounded to figure out which option is better.

Yield Before Investing

But remember -- as is the case with many investments, there can be small print! Before you invest in the best APY you find, look at other account details. Check for annual fees, which do not have to be disclosed in the APY calculation. Ask your banker about specific requirements of the investment, including annual fees and minimum deposit balance fees, to really compare options.

To compare large banks, search the internet for “compare APY and fees.” This will give you many site options for savings comparison, such as this one.

Stay tuned for the next post in the series where we take a look at Yields and Bonds.

This post appears in the Carnival of Wealth. Head over there to read more great posts about wealth building.

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